UK Productivity Performance and Policy

Recent work on UK Productivity Performance and Policy

A key area of interest at the CEP, and in the Productivity and Innovation Programme in particular is understanding the UK's historic productivity performance, and drawing on this and the wider body of economic research to propose policies for sustainable growth. These issues have become all the more pertinent following the financial crisis and prolonged recession that ensued. The work in this area recently culminated in the LSE Growth Commission which reported in early 2013 on how to formulate and implement a long-term growth strategy in the UK.

Here we summarise some recent papers which are concerned with UK productivity, both over the longer term and performance since the financial crisis (the so called 'productivity puzzle').

Dan Corry, Anna Valero and John Van Reenen (2011) found that the UK's economic performance was strong from 1997 up to the financial crisis compared with its main international peers, and that this was not driven just by finance; the distribution and business services sectors were more important. This continued a trend which began in a period of Conservative government (1979-1997) which reversed a century of British economic decline. It is argued that Labour's policies subsequently contributed at least in part to the strong productivity performance, through growth of education, support for innovation and tough competition policy. Arguments against excessive austerity are provided and recommendations made for a longer-run growth policy.

Drawing on this article, and research that analyses the UK's poor productivity performance since the financial crisis in more detail, John Van Reenen argues that the main conclusions on the period of Labour government remain unchanged: most other OECD countries have experienced poor productivity in that period too.

Nicholas Oulton (2013) discusses the wide range of hypotheses which seek to explain the productivity collapse in the UK following the financial crisis, including the impact of austerity. Most of the conclusions are negative: in the sense that the explanation in question doesn't work. He considers long run impacts of banking crises and argues that they generally impact on the level of productivity but not necessarily on its growth rate. He predicts that the UK will eventually return to the growth rate predicted prior to the crisis. This prediction is conditional on the UK continuing to follow good policies in other respects, in particular not allowing the government debt-GDP ratio to rise excessively.

João Paulo Pessoa and John Van Reenen (2014) analyse the unprecedented fall in UK productivity since 2008, which has been termed the 'productivity puzzle'. They argue that the fall in the capital-labour ratio (or 'capital shallowing') could be the main reason for this. This is likely to have occurred due a large fall in real wages and increases in the cost of capital during this period. Reforms to union strength and welfare have made wages more sensitive to negative demand shocks and explain the recent fall. After accounting for changes in capital, TFP is more similar to earlier recessions and likely to be related to under-utilised resources and misallocation. The fall in labour productivity is therefore likely to reverse if demand improves - e.g. through stronger monetary or fiscal policy stimulus.

Nitika Bagaria, Dawn Holland and John Van Reenen (2012) assess the impact of the scale and timing of the fiscal consolidation programme embarked on by the UK's Coalition government on output and unemployment in the UK. They consider three scenarios: the consolidation plan implemented during a depression; the same plan, but with implementation delayed for three years when the economy has recovered; and no consolidation at all. The modelling confirms that doing nothing was not an option and would have led to unsustainable debt ratios. Under both consolidation scenarios, the necessary increases in taxes and reductions in spending reduce growth and increase unemployment, as expected. But the impact would have been substantially less, and less long-lasting, if consolidation had been delayed until more normal times.

Against the background of growing euroscepticism in the UK, and the commitment of the Conservative party to a referendum on the UK's membership of the EU in 2017, Gianmarco Ottaviano, João Paulo Pessoa, Thomas Sampson and John Van Reenen have modelled the economic impacts on the UK were it to leave the EU. They find that a 'brexit' would have a significant negative impact, with the most important costs resulting from higher trade barriers with the EU. They model two scenarios relating to how easy it is for the UK to trade with the EU, and find that Brexit would decrease UK income by over 1% of GDP in the most optimistic case and over 3% in a pessimistic case. These are static analyses, in the sense that changes in growth rates are not accounted for. Including the dynamic effects is likely to more than double these estimated losses.

In a project funded by the Resolution Foundation and the ESRC, João Paulo Pessoa, and John Van Reenen (2013) assess whether UK wage growth began to fall behind productivity growth, as is widely believed to be the case in the US. They find that this is not the case. While there is evidence of 'gross decoupling' (i.e. the difference between the median wage and productivity has risen), there is no evidence of 'net decoupling' which involves a measurement of deflating wages in the same way as GDP. Their analysis of the difference between gross and net decoupling implies that it is not the balance between wages and profits that needs to be addressed, but inequality among employees.

Related work by Brian Bell and John Van Reenen (2011) looks at the relationship between firm performance and wages using a panel dataset covering 90% of the market capitalisation of the UK stock market. They show that senior management appear to have pay that is strongly associated with various measures of firm performance while workers' pay is only weakly associated with such measures. This is essentially a result of the responsiveness of flexible pay to performance and only senior executives have a large enough share of pay in bonuses to generate a sizeable overall effect on pay.

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